Question

A. Computer stocks currently provide an expected rate of return of 14%. MBI, a large computer company, will pay a year-end dividend of $4 per share. If the stock is selling at $80 per share, what must be the market's expectation of the growth rate of MBI dividends? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

Growth rate %
b-1. If dividend growth forecasts for MBI are revised downward to 4% per year, what will be the price of the MBI stock? (Round your answer to 2 decimal places.)

Price $
b-2. What (qualitatively) will happen to the company's price–earnings ratio?

a.Increases
b. Decreases

Answer 1

a. Dividend growth rate = 9%

b. $40

c. If Price is reduced then Earning per share will also decrease.

Step-by-step explanation:

a. The computation of Growth rate is shown below:-

Share price = Expected dividend ÷ (Cost of equity - Dividend growth rate)

$80 = $4 ÷ (0.14 - Dividend growth rate)

11.20 - 80 × Dividend growth rate = 4

Dividend growth rate = 9%

b-1 The computation of Price is shown below:-

= Expected dividend ÷ (Cost of equity - Revised downward percentage)

= 4 ÷ (0.14 - 0.04)

= 4 ÷ 0.10

= $40

b-2 If Price is reduced then Earning per share will also decrease.